Auctions Bill Is on Agenda for TARP Warrant Hearing

The $700 billion bailout bill required the Treasury Department to obtain warrants from bailout recipients. The warrants give the owner the right to buy stock by some future date at a preset price. One of the overseers of the Troubled Asset Relief Program, Harvard professor Elizabeth Warren, alleges that the U.S. Treasury has been selling the taxpayers’ warrants back to the banks at 66 cents on the dollar. Not many people would like it if their Uncle Sam sold their $300,000 house for $200,000. Yet, that is what the July 2009 Congressional Oversight (COP) Panel Report alleges that Treasury is doing with the taxpayers’ warrants.

This report has many of the House Financial Services subcommittee on oversight and investigations members ready to take matters into their own hands. Democratic subcommittee members Mary Jo Kilroy (Ohio), Alan Grayson (Fla.), and Jackie Speier (Calif.) have introduced legislation to force the U.S. Treasury to auction the TARP warrants of banks receiving greater than $250 million in TARP monies.

Prominent economists -- Brad Delong and Simon Johnson, and "Mad Money" star Jim Cramer among them -- have argued that auctions are a great idea. An auction to third-party buyers will provide a true market price, increase transparency, reduce the potential for corruption and avoid draining bank capital. My analysis of the 1983 auction of the taxpayers’ warrants issued by Chrysler Motors indicates that auctions lead to higher prices for taxpayers than negotiations.

The committee will first hear newly confirmed TARP chief Herb Allison. He will attempt to impress (bore) the committee with the U.S. Treasury’s professionalism and valuation acumen.

We should be looking to see if Allison offers up any timeline for the J.P Morgan warrant auction. The auction of J.P. Morgan’s 88.4 million warrants promises to be the largest warrant auction in U.S. history. The billion-dollar-plus warrants of Goldman Sachs and Morgan Stanley are still under negotiation and “tacky” Goldman Sachs is too hot to handle right now. Look for lots of grandstanding on Wall Street pay in front of the Allison, the ex-president of Merrill Lynch. Recently, Goldman Sachs set aside over $700,000 per employee on an annualized basis for compensation, and Morgan Stanley is due to report second-quarter earnings (and compensation) this morning I’m sure Allison’s predecessor and ex-Goldman Sachs investment banker Neel Kashkari is happy to be watching at home.

I estimate that taxpayers got about $200 million less than fair market value in most recent warrant buybacks of BB&T, U.S. Bancorp, and State Street. These repurchases were shrewdly, from Treasury’s point of view, consummated after the COP report was released July 10. Thus, I expect little discussion of these very expensive deals for U.S. taxpayers.

Allison will wisely beat a retreat before his accusers step up to the microphone: the aforementioned Warren of the COP; Neil Barofsky, the ex-prosecutor who heads of the Special Inspector General’s office on the TARP (SIGTARP); and Thomas J. McCool, director of the Center for Economics at the Government Accountability Office. While Warren’s report will probably steal the limelight, I expect the representatives of SIGTARP and GAO will land some jabs. The latest SIGTARP report doesn’t have much to say about the warrants and even stopped listing the strike prices at which the stock can be bought. Yet, I expect for calls by Barofsky for the Treasury to post the market value of the investments on a monthly basis. The Treasury has this information, but it refuses to disclose it. McCool, based on his agency’s report, is likely to join Warren in calling for Treasury to disclose the formal bids in the warrant negotiation process.

I would personally like to see the Treasury disclose when a bank has exited warrant negotiations. Right now there is no reliable way to tell which banks have warrants that will be auctioned. This is something that investors would definitely like to know. More time for investors to price the warrants will likely lead to higher auction prices, benefiting taxpayers.

The hearing on “TARP Oversight: Warrant Repurchases and Protecting Taxpayers” is at 2 p.m. today in 2128 Rayburn House Office Building and will be webcasted live.

--Dr. Linus Wilson is an assistant professor of finance at the University of Louisiana at Lafayette. He tracks the TARP warrants and has written several research papers on the bank bailouts, including government plans to buy toxic assets and the effectiveness of common as opposed to preferred stock in encouraging lending. He also occasionally writes articles on the TARP at Seeking Alpha.